Business Owners Beware: Document Loans to Your Company or Else- Trends in Debt vs. Equity

Asset Protection Attorney Alert:

Have you ever loaned money to your own company?  Have you ever loaned money from one company to another?  Do you have written loan agreements in place?  Do your accounting records properly document the amount owed, transfers made, regular payments, and accruals of interest? Courts are coming down on these types of arrangements.

It is all too familiar to see when it comes to small and closely held businesses.  The owner puts some of his or her own personal funds into a company or transfers money from one company to the other to cover expenses for that company.  Most owners don’t think twice about it since they don’t have many other shareholders to consider or seek approval from.   Rarely do we see clients who come in who have entered into those kinds of deals that present documented loan agreements or any kind of records, but they think “it’s my company, so it doesn’t really matter” or “I am not publicly traded with the SEC or a big board of directors watching, so who cares.”  What they may not realize is that it can end up hurting the company or the shareholder down the road and, in some cases, in a pretty drastic fashion.

Several recent court cases have emphasized just how much not documenting loans can hurt a company.  Most of these arise in the bankruptcy context, but can be applied to regular state law claims related to loans, which can affect nearly anyone.  Even a minority shareholder could try to use these principles to his or her advantage to avoid loans the company owes to a majority shareholder.

The cases involve an extension of the bankruptcy court’s powers when it comes to debts.  A bankruptcy court has broad equitable powers under Section 105 of the Bankruptcy Code to make changes to carry out a bankruptcy.  On March 4, 2014, the US Supreme Court in Law v. Siegel issued an opinion that put a few restrictions on the recent expansion of those powers, but the concerns for business owners are still there and it is clear that the bankruptcy court’s use of those powers is still valid.

Since this ruling, a bankruptcy appeals panel has held that Law v. Siegel does not go so far as to ban a bankruptcy judge from recharacterizing debt as equity, which is more relevant for business owners.  The case of In Re: Alternate Fuels, Inc. was decided by the 10th Circuit Bankruptcy Appellate Panel on March 18, 2014 finding that loans by a shareholder to the company were equity and not a loan, despite the ruling in Law v. Siegel.

The facts of other recent cases are similar in that the court eventually converted what was claimed to be debts owed by the company to a shareholder/owner into equity.  The shareholder would put money into a company and then claim the company was required to pay it back and make a claim in the bankruptcy court to get paid back.  The courts have found that some of these so-called “debts” were really equity investments by the owner into the company with little to no value.  In a bankruptcy liquidation, if there are assets available, the assets are distributed according to priority to certain liabilities and if all liabilities are paid, then what remains gets distributed to equity holders/owners.  In a bankruptcy repayment or reorganization, such as is common in Chapter 11, the debt holders get paid off over time, but the equity holders do not receive payments.  When the court says that someone with a debt really invested equity and converts it into equity, they are saying that in most cases, that person is out of luck and will probably not get anything.

The cases look to the elements reviewed by state courts when analyzing whether a transfer of an asset could be considered a fraudulent transfer to avoid creditors.  If there is no transfer for something of reasonably equivalent value and there is no real obligation to pay the loan back, it could be considered fraudulent resulting in the loan not being allowed as a legitimate claim and an unwinding of the transaction.  This could result in a company or shareholder loaning money to another company he or she owns and losing that money.

Additionally, these loans have an impact in the context of asset protection planning.  For example, say John Q. Shareholder owns 2 LLCs: Bad Credit, LLC and Money Maker, LLC.  Bad Credit, LLC defaults on some loans and gets sued by a bank.  The bank gets a judgment against Bad Credit, LLC, but learns that Bad Credit, LLC would frequently pay for expenses of Money Maker, LLC.  Mr. Shareholder saw nothing wrong with this and even used one bank account to receive income and pay expenses for both LLCs.  The bank will go to court and try to collect against Money Maker, LLC and Bad Credit, LLC arguing that they are really not different companies due to the commingling (sharing) of assets.  Mr. Shareholder will try to claim the expenses paid by Money Maker, LLC were just loans to Bad Credit, LLC, but when it comes time to prove they are loans, he fails.  The court decides that the two LLCs with common ownership, similar bank account, and shared expenses are really just one company and the bank can go over both LLCs for the debt.  Or even worse, the bank says that both LLCs are really nothing more than Shareholder’s alter ego and the bank can now collect against Shareholder personally.

So what can be done?

A court is more likely to find a valid and enforceable loan when there is a well drafted written loan agreement in place and it is actually treated like a real loan.  This could be an inter-company loan agreement, promissory note, revolving credit line agreement, or other debt document.  The loan has to be for reasonably equivalent value to what is being provided and actually have terms that could be enforced.  If there are regular payments due, those must be paid and documented.  If there is interest due (which there should be at least some minimum amount provided for), it should be regularly accrued and put on the company’s books or accounting records.  These are just some of the actions that need to be taken to protect those dollars you lent to the company.  The more a court would view the arrangement as similar to what a bank or some other outsider lending money would put into place, the more likely the court would enforce the loan or keep liabilities separated from the owner or other companies.  It is also highly recommended to avoid commingling (sharing) funds or bank accounts between companies or owners, but I realize that the day to day needs of a company may not allow that kind of requirement to be kept.  If you have an LLC or corporation, be sure you have a separate bank account in that company’s name and try not to run any personal expenses through it.

A little planning can avoid courts turning your loan into worthless equity or making your personal assets vulnerable to creditors. Avoid these situations altogether with valid legal loan agreements, documented accounting, and segregated accounts and funds, so business owner beware!

Entrepreneurs Suffer Credit Problems In Economic Hard Times

Many small business owners or other entrepreneurs start out with a great idea for a new product or service.  They start a business and focus on doing whatever it takes to make the company successful.  Many don’t take the steps necessary to properly protect the business from creditors or don’t really pay much attention to what they sign when they are making deals.  The ones who do read the fine print may just have the attitude that they are so confident in the business’ success, who cares if they use their own personal credit to get some working capital.  With the economic downturn over the last few years, many business owners have had to close their doors because they couldn’t get the funds they needed to even cover the simple things like payroll or rent.

Use of Personal Credit

Many entrepreneurs feel that they should put some ‘skin in the game’ by contributing some of their own money into the business.  In fact, the Small Business Administration backed loans often require the founders to contribute at least a certain percent of their own assets or some other major contribution in order to qualify for a business loan.  When the owner doesn’t have available cash, they look to other sources to get the money to contribute.  That can lead to things like taking out a home equity line of credit or using personal credit cards to help fund the business.  Obviously that is pretty risky, but often necessary to get early access to this seed money to start and grow.  The banks that issued the credit did so based upon the owner’s personal credit rating.  Just because the credit card may have the business’ name on it doesn’t mean the bank hasn’t covered their bases by making sure they can sue the owner personally if the business defaults in payment.

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Bankruptcy Petition Preparation Company Problems

Many people who think about filing for bankruptcy often want to avoid legal costs and either look to do their case themselves or pay a petition preparation company that charge anywhere from $200 to $500 to prepare the forms. The problem with not at least consulting with a qualified bankruptcy attorney is that you are going into a very complex federal court system. It is not just a matter of a few simple forms.

If your forms and schedules are not done properly with the most up to date forms or they are not filed in compliance with the federal and local rules of procedure, your case can be dismissed within a matter of weeks of filing. Not only will you have to possibly pay the filing fee again to re-file, the court often imposes a ban on re-filing for 6 months. The court can also prohibit re-filing for an even longer time if they think your filing was an abuse of the system.

I have clients come in and end up spending even more money in the long run for me to fix the problems and properly advise them than if they would have just come to me in the first place. Petition preparation companies often give legal advice, even though they are not supposed to. They tell people that they can remove 2nd mortgage or qualify for chapter 7 filing status, only to have the client later learn that they were not properly advised.

Most bankruptcy lawyers will offer free consultations, so even if you don’t hire them, you should at least get some advice before moving forward to be sure you are properly represented.

Chris Barsness, Bankruptcy Lawyer
http://www.bankruptcylawyerla.net

Credit Repair After Bankruptcy – Steps To Take

Even after one files bankruptcy, there are still steps that need to be taken to improve your credit score.

1) Be sure to check with credit agencies after filing. Many people are scared to look at their credit report after filing, but you should several months after filing or discharge to be sure everything is accurate. You want to be sure the bankruptcy is listed and any discharged debt doesn’t show as anything more than a bankruptcy filing.

More can be found at this article below:

RT @NYDailyNews: There is life after bankruptcy http://bit.ly/c5rWzT

http://www.nydailynews.com/money/2010/04/05/2010-04-05_there_is_life_after_bankruptcy_credit_could_thaw_in_1824_months.html

2) Make attempts to obtain credit after discharge. You can get secured credit cards by applying for that specific type of card. You simply give collateral, such as equity in a car or cash, to show the creditor they have something of value to collect if you don’t pay.

3) Any debts not discharged or incurred after filing must be paid on time. Don’t think that “oh well, my credit is shot anyway.” If you make all your payments on time after filing, you can be on the road to financial recovery.

Chris Barsness

http://www.bankruptcylawyerla.net

California Bankruptcy Attorney Uses Chapter 11 to Stop Foreclosure

A bankruptcy filing has the effect of placing a court order stopping foreclosure and eviction. It gives homeowners time to try to work out a solution to their financial problems. Loan modifications are few and far between these days and do not guarantee the bank won’t sell the home during the process.

Many people do not realize that Chapter 7 and 13 are not the only alternatives when it comes to filing for bankruptcy. Chapter 11 is a reorganization like chapter 13, but can be used for individuals to accomplish foreclosure relief, debt reorganization, and lien stripping that essentially results in principal mortgage reduction. A homeowner’s primary residence 2nd mortgage can only be lien stripped if the home’s value is less than what is owed on the 1st mortgage. Rental or investment properties 1st and 2nd mortgages can be lien stripped in certain circumstances in Chapter 11.

Even in Chapter 13, a homeowner can benefit by removing the 2nd mortgage, resulting in more available income.

Consult with a bankruptcy attorney to review your options. Many, including our firm, provide free consultations to see if bankruptcy may be the right option for you.

http://www.bankruptcylawyerla.net

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How to file bankruptcy – consult a bankruptcy attorney

Record numbers of bankruptcy cases are dismissed by the court as they are not being filed properly. Both local and federal rules of bankruptcy procedure require compliance with filing deadlines and format of forms, schedules, and other documents. People want to avoid the costs of hiring an attorney, but they end up wasting the $300 filing fee and time involved by filing improperly only to have the court dismiss the case 14 to 30 days after filing.

If you are trying to rearrange your finances and get back on your feet, an experiences bankruptcy attorney can help you make sure you handle your case properly. Realize that you are eliminating debts and monthly payments, so an investment in your financial future is worth the cost. Most bankruptcy lawyers are willing to work with you to figure out how to pay the costs involved for their advice and representation.

In addition, a bankruptcy lawyer can explain advantages that you may be able to take advantage of, such as eliminating second mortgages on your home, saving your home from foreclosure, and other pieces of advice and counseling.

http://www.bankruptcylawyerla.net

Bankruptcy & Short Sales Better Option Than Modification

The recent announcement by President Obama of incentives to homeowners of $1,500 for selling their home in a short sale is just further evidence that lenders are unwilling or unable to complete realistic loan modifications. The President is realizing that lenders would rather take a short sale loss and move on than deal with modifications.

Many homeowners get emotionally attached to their homes, but they need to be realistic. If you are in a position where you cannot afford the existing payment and are severely behind in payments, it is unlikely a loan modification is going to help. With only 66,000 modifications in 2009 under the Obama HAM program nationwide, it seems unlikely that anything is going to get better.

Once homeowners realize that they may not be able to save their home and realistically think about moving on, they can properly evaluate all possible options. Many homeowners end up losing their homes during a modification review and end up with personal liability on 2nd or 3rd mortgages. Bankruptcy can be a useful tool to resolve some of these issues. It can be used to remove 2nd liens and bring a homeowner current on back owed payments.

The other options are short sales or deeds in lieu of foreclosure. Homeowners should consult with a local real estate or bankruptcy lawyer to be sure they are protecting their finances moving forward.

Chris Barsness

http://www.bankruptcylawyerla.net

Eliminate 2nd and 3rd mortgage, reduce principal

Many homeowners are pounding their heads against a wall trying to get lenders to work to get them current or give them some form of loan modification. Many of these homeowners have been taking out of credit cards, personal loans, or other sources just to survive. However, many lenders look at large amounts of other debt negatively when considering your total debt to income ratio in a modification. These homeowners don’t realize that a loan modification is not going to suddenly save them from the brink.

Often times a bankruptcy filing is a better option. It can eliminate the other credit card debts, personal loans, 2nd mortgages, and 3rd mortgages. It all depends upon the type of filing under what chapter of the Bankruptcy Code, but it is even possible to force principal reduction in some cases. Although there have been attempts at federal legislation over the last year to allow bankruptcy judges to force modification of terms of mortgages on principal residences, they are always defeated. There are ways to eliminate 2nd mortgages even on principal residences in some cases.

Homeowners needs to look at all their options and not delaying because your lender will move a foreclosure forward no matter how seemingly nice them seem on the phone.

For more information, contact us or view our website.
888-881-6591
http://www.bankruptcylawyerla.net/BankruptcyServices.htm

Bankruptcy- do it yourself or hire an attorney?

Many people question whether they should save money by filing their own bankruptcy case or hiring a petition preparer or other online source that puts the forms together. Bankruptcy is a federal court case that can have long term implications on a person’s credit, finances, and their life in general. People pay for health insurance and pay to see a doctor when anything might affect their health long term, yet they fail to seek expert advice when it comes to their financial health.

Many of our cases come from people who did their case on their own and now have to pay significant fees for us to correct what was done improperly in the first place. The bankruptcy code is a complex set of laws and procedural rules, many that vary by court location with local rules. Many petition preparers do not have access to the local forms that need to be filed. Petition preparers or doing it yourself does not give you the proper guidance and legal review of which bankruptcy case is best for you, how to prepare for bankruptcy, how to list assets and debts, how to go through the process, which exemptions to claim, how to save your home or other assets, and how to minimize the long term impacts. If you fail to properly file the required forms, including required local forms, the court can dismiss your case. At that point, you would have to pay the filing fee again to refile and have lost weeks or months that your case could have been moving forward.

If you fail to list a debt, you can still have liability for it after the case. Our firm runs checks to be sure we are aware of all debt that may be out there, even some that you may have forgotten about or didn’t even know was there.

Bottom line, be sure to investigate all the possible consequences before deciding to do your own bankruptcy. It may sound better to save the money and not get expert advice, but realize that you are eliminating all kinds of debt, so paying a little up front to be sure you are protected and getting rid of hundreds or thousands of dollars a month in payments can be worth the investment.

For more information, go to our website or call for a free consultation 888-881-6591.

http://www.bankruptcylawyerla.net/BankruptcyServices.htm